Abstract

This present study argues that economic freedom is a necessary antecedent to China’s structural economic rebalancing. Therefore, using an index of economic freedom, it seeks to examine the implications of economic rebalancing on banks’ profit efficiency following a freer Chinese economy. Our dataset includes an unbalanced panel of 514 annual observations from 138 commercial banks that operated from 2007 to 2013.

This study found evidence that higher freedom index of government spending, which denotes contraction of government expenditure, will result in lower profit efficiency.

However, on a more granular level, the reduction of efficiency does not apply to state-connected banks, which are seen to be more profit efficient. On the other hand, the reduction of profit efficiency that afflicts other commercial banks that are less connected to the state authority can be mitigated by the increased aggregate demand from the private sector, following greater fiscal freedom and trade freedom through cutback on the tax rates and lower trade barriers, respectively.

In addition, save for state-owned commercial banks, lower monetary freedom is found to significantly increase profit efficiency across banks of all ownership types. This corroborates the fact that banks have more extensive capacity to anticipate inflation compared to depositors and thus, they are more likely to thrive in an inflationary environment.

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